Patrick

I'm Patrick Coffey. This is the Barclays brief. And today we're focused on France. And that's because there have been some very big moves in the French government bond market, as investors grapple with the country's fiscal outlook and the rose to the 2027 French election. Quick bit of jargon busting before we get into it. So today you're going to hear us talk about the OAT or the OAT Bund spread. OATs are French government bonds and Bunds are German government bonds. So, the spread is simply the gap between their borrowing costs. And it's a useful gauge of how investors are viewing the risk around French debt compared with German debt. And it also gives our research analysts a great opportunity to put a pun in the title of their notes. So, this week we've had OAT of control, OATs gone wild, and my favourite OAT of the frying pan into the fire. Now the author of that note is Rohan Khanna, our European Rates Analyst. Rohan, thanks a lot for joining.

Rohan  

Thanks, Patrick. Great to be here. And in fact, this is perfect timing because I am here in Paris at our inaugural European Macro Conference. And this is exactly what everyone wants to talk about.

Patrick  

Indeed, indeed. So European bond yields have been rising sharply. Of course the US has as well. But investors right now seem particularly focused on France. What's driving that concern?

Rohan  

To be fair, France has been in the markets crosshairs since President Macron called a snap election in June 2024. It left the parliament in a very fragmented state, and France now has its fifth Prime Minister in the last three years. Now, this rise in political uncertainty came at a time when France's fiscal fundamentals were already weakening for a considerable amount of time. Precisely because of this reason, budget negotiations in 2024, 2025 have been periods of significant market stress. For 2026, this has been a perfect storm for European bonds and specifically for French debt. That's because the Gulf conflict put the ECB on a rate hike path, and all the calm that the market had observed over the last year went away. On top of that, France has to issue a lot of debt. But once again, it's come down to the budget. Now France is presenting its 2027 budget. They've had to once again increase the deficit estimate for 2026. They were targeting for -5%. It's expected to be -5.4. And they've set an ambitious target for next year at -5%.

Patrick  

Indeed. And when the budget was announced a couple of weeks ago, there was a bit of scepticism, to say the least, about some of those forecasts for 2027. And now everyone's very focused on the French election, which isn't until April next year. How much does the outcome of that election matter for markets, and what are the polls telling us today?

Rohan  

Absolutely. I mean, the polls matter immensely, given the market wants to see willingness and ability from policymakers to address France's domestic challenges. Now, you mentioned that there was some scepticism about the budget forecasts. And that's absolutely right. Our economists, the High Council of Public Finances in France, which is the budget watchdog, both believe that the government's growth forecasts for next year are quite optimistic. So the market wants to see a credible political solution for France's growth and fiscal challenges. And this is where the parliamentary elections and the presidential elections become so important. Now if you look at opinion polls, they are pointing to one of the largest and most significant political resets in France's history. If you look at the first-round opinion polls, they are pointing to Madame Le Pen having a clean victory. And in the second round, most opinion polls again suggest that Madame Le Pen is likely going to be the winner. But the story doesn't end with the presidential election, because whoever wins is very likely to call a parliamentary election, and it will be the shape of the parliament in terms of whether there is any party that can get an absolute majority. Or will we once again have the muddle through minority government that has been in place since Mr. Macron’s second presidency. That is what the market wants to see, because if we are stuck in the same situation as we are today where we have a minority government, then getting anything done is going to be very difficult. So, your challenges of high deficits, ever increasing debt to GDP are going to get even harder to be addressed if there is not an absolute majority to address those difficult challenges.

Patrick  

Okay, so put it together. We've got scepticism at the current budget, and we've got a lot of uncertainty around the winner of the French election. Let's then talk about bonds, which is your area of absolute expertise. And think about the OAT Bund spread. How much of the move in that spread do you think reflects the broader bond market dynamics that we talked about here on the Barclays Brief a lot. And how much is specifically about French politics and French public finances.

Rohan  

If we reflect on what's happened with OAT Bunds since June, and I'm going to kind of benchmark it to June, because that's where things blew up really. OAT Bunds would have widened between 60 to 70 basis points. Now remember bond yields have risen everywhere. Ten-year German yields have risen by about 60 to 70 basis points. Ten-year OAT yields of French yields have risen by about 120 to 130 basis points. And across the EGB complex you've seen yields go up. So it's not just a France story, but the widening that you see in OAT Bunds is a reflection of the idiosyncratic French specific dynamics where you have deficits, you have a budget that has to be decided and on top of that, you have political uncertainty. Now, if you reflect on what is the market telling you, the markets telling you that the level of uncertainty and the challenges that the French policymakers face are causing a buyer strike. Market participants want more clarity and credibility before they can go back and buy OATs at these level of spreads, but the runway between now and the election is quite long, so we are probably stuck in a period of prolonged uncertainty.

Patrick  

Yeah. You described it at the start here as a perfect storm in France. Do you think the bond market has now priced in all of this bad news, or is the market still waking up to the fiscal risks in France?

Rohan  

If we look at a very long chart, Patrick, what we'll see is that the current level of ten-year France versus German spread or the OAT Bund spread is higher than any time since the European debt crisis of 2011, 2012. But this is where it's important to keep things in perspective, because the political reset and the fiscal math that France faces are both so challenging that, in our opinion, the spread is unbounded. We need to work through the wall of worry and the fog of uncertainty before we can confidently say that the market is pricing the right thing for OATs. So in our view, the market is waking up to the fiscal risks. The political uncertainty is a big deterrent for buyers to step in. And we may have not seen the worst.

Patrick  

Okay. So we may not have seen the worst. I imagine that some of our listeners will immediately think back to the eurozone crisis. How valid is that comparison? And is this primarily a French story or could it be something bigger?

Rohan  

That's a great question, Patrick. And absolutely, the way bond markets have behaved over the last month, it is indeed reminiscent of the behaviour during the European debt crisis. But I think we should draw a clear difference between that episode, which was a case of everything everywhere all at once, versus this episode, which is an idiosyncratic, France specific issue from a banking sector perspective. I don't think the kind of sovereign bank nexus that was prevalent back in the debt crisis is really applicable. But most importantly, this is about fiscal trajectories. France’s fiscal trajectory is clearly upward sloping, meaning debt to GDP is set to rise under various circumstances. When you look at Spain, Portugal, Greece, these are clearly examples of countries where debt to GDP is a downward sloping trajectory. So it is drawing a comparison with European debt crisis I think is incorrect at this instance because this is clearly a crisis where fiscal trajectories are divergent and the market is waking up to what France’s fiscal trajectory really holds.

Patrick  

Okay, that's definitely a relief. But now let's think about the road to the 2027 French election. What are the key milestones and the risks that investors should be watching right now?

Rohan  

I think people are going to be very focused on the evolution of opinion polls, because if there is a situation where the second round becomes a tussle between Madame Le Pen and Mr. Mélenchon, then you have two far right and far left candidates going up against each other, and that is potentially a negative outcome for the market.

Patrick

Okay. And so last thing. We're recording this on Wednesday the 7th of October. And just yesterday Madame Le Pen held a press conference introducing their economic manifesto she's going to put forward as their and I quote, “counter budget for 2027”. Just very briefly, what's the market reaction to that press conference yesterday?

Rohan  

In spirit, we can draw comfort from the fact that she's making the right noises. She understands that France is having a significant challenge on the fiscal front, and that needs to be addressed. Otherwise, the markets are going to have an even severe tantrum. So in spirit, you have to give full marks. The problem, though, is implementation. And this is the frustrating bit because having seen this widening, even the most ardent believers in the France story who want to be long OATs have to still wait to see the outcome of the election, to see who becomes prime minister, who becomes finance minister, and whether the new administration, in whatever shape or form it takes, has the willingness and the ability to implement the proposals that have been laid out.

Patrick

So the road ahead is long in France. Rohan, thanks so much for joining me today. This has been fascinating and great to hear from you.

Rohan   

Thank you Patrick.

Patrick  

Now there's likely to be more volatility ahead, and markets may yet demand a higher risk premium for French debt. But for all the concern, Rohan has made it clear that this is not 2011 and the eurozone crisis. The story today is a repricing of French fiscal and political risk, not an existential threat to the euro area. If you've enjoyed today's episode with Rohan, do hit subscribe and will be back next week with more from The Barclays Brief.